Turkish economy depends on political stability

A pedestrian walks past a barricade, with the Bosphorus Bridge in the background, near Taksim Square in Istanbul, Monday June 10, 2013. Protesters gave the name Abdullah Comert to the barricade, red sign, after the protester who died last week during clashes in the town of Antakya, southeastern Turkey. Turkey's main opposition party leader Kemal Kilicdaroglu has called on the prime minister Recep Tayyip Erdogan to stop escalating tensions as anti-government protests that have led to three deaths entered their 11th day. (AP Photo/Thanassis Stavrakis)

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LONDON (AP) — The escalation in the clashes between Turkey's government and protesters could hurt an economy that has become a source of growth and stability in a region hit by recession and unrest.

The protests started 12 days ago as a demonstration against plans to bulldoze and redevelop a park in central Istanbul. They weren't very different from the Occupy Wall Street protests in New York. But the authorities' heavy-handed use of tear gas and water cannons only fueled popular outrage among Turkey's secular middle class.

The demonstrations have spilled over to other cities and grown in size in what has become a test of Prime Minister Recep Tayyip Erdogan's authority and a rejection of what some see as his autocratic ways. In the latest clash on Tuesday, riot police overran demonstrators' barricades in Istanbul's Taksim Square.

The heightened tensions have raised fears that a key regional power could be destabilized. Water cannons and tear gas were used against the hundreds of protesters in Taksim Square, Istanbul, many of whom have fled into a nearby park.

Here's a look at the Turkish economy and the risks it faces.

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HOW BIG IS TURKEY'S ECONOMY?

Annual economic output in this country of about 75 million people is about 5 percent of the U.S.'s. At $10,000 per person, it is around the same level as Brazil or Mexico and has been growing at a steady pace.

Its neighbors, by contrast, are almost all in the midst of economic and social upheaval. Greece and Cyprus have been embroiled in Europe's debt crisis and fallen into deep recessions, while many of its neighbors to the east — Iraq, Syria and Georgia — have seen their economies shattered by war and popular uprisings.

Though impacted by the developments around its borders, Turkey has managed to blaze a trail. Since an economic crisis at the turn of the millennium, growth has averaged at a little over 5 percent a year. In 2010 and 2011, when much of the global economy was trying to recover from recession, Turkey was growing by over 8 percent, more or less the same rate as China, the world's second-largest economy.

Turkey's economic performance has enhanced its political profile in the world. As a member of the Group of 20 leading industrial and emerging countries, it has a voice in discussions on the world's biggest issues.

Economic growth has recently taken a tumble, however, as the country suffered from a drop in demand from major trading partners in Europe, where many countries are in recession. Annual growth slowed to 2.6 percent in 2012, and the International Monetary Fund has projected it should accelerate slightly to around 3.5 percent this year and 3.75 percent next.

Those rates are still relatively low for a country that has enjoyed a boom over the past decade and could leave the economy all the more fragile should the political unrest in Turkey escalate.

The latest figures on Tuesday showed the economy grew by 3 percent year-on-year in the first quarter, up from 1.4 percent in the previous three-month period. The increase was higher than expected — the consensus in the markets was for a more modest 2.3 percent rise.

What has impressed many analysts over the past 10 years is the broad nature of Turkey's economic development. The industrial and services sectors have expanded alongside tourism. Inflation, which had been high for decades, hitting 90 percent as recently as 1999, has come under control. The IMF predicts a fall in inflation to 6.6 percent this year from 8.9 percent in 2012.

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HOW HAVE INVESTORS REACTED TO THE UNREST?

Not well. Markets fell sharply during the first days of protest and government clampdown and have remained volatile since, suggesting the international investment community is on edge.

Despite gains Tuesday in the wake of the growth figures, the main stock index is still down almost 12 percent since the protests started. The national currency, the lira, has dropped about 6 percent against the dollar, to about 53 cents per lira.

The interest rates on government bonds have risen sharply, indicating foreign investors are more worried about lending money to the Turkish government. The benchmark 10-year yield has risen from 6.2 percent to 7.3 percent. Because economic growth and inflation are relatively high — helping to erode public debt — the government is expected to be able to keep borrowing at these rates. That means it's unlikely to need to call on the IMF for a bailout, like neighboring Greece.

But it is nevertheless a bad sign for a country whose economic growth has depended heavily on investment from beyond its borders.

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WHAT ARE THE RISKS TO THE ECONOMY?

The biggest threat is that political turmoil scares foreign investors into pulling their money out of the country.

The stability of Erdogan's government, which has been in power since 2003, has been one of the reasons investors have flocked to Turkey.

Turkey has launched a series of massive infrastructure projects, such as a huge new airport outside Istanbul, a third bridge across the Bosporus straight that divides Istanbul, and oil pipelines that cross the country. To pay for these works, the government and major corporations have been issuing bonds that investors in the U.S. and Europe have been eager to buy because they potentially yield better returns than financial assets back home.

Political turmoil increases the risk that such investments might not be repaid as expected. A new government, for example, might change the tax rates or overhaul laws protecting foreign investors' rights. In such a case, investors could opt to pull their money out and place it in a more stable country.

"The risk now is that a renewed period of political uncertainty dents confidence and causes investment flows to reverse," said Neil Shearing, chief emerging markets economist at Capital Economics.

Although some have made comparisons between the Turkish protests and the Arab Spring uprisings that have toppled governments in several Mideast countries, the similarities are in fact few. The government was voted in and still enjoys strong support. So there is no immediate risk of the same kind of violent uprising.

"The demonstrations have not been on the scale that would bring about the kind of economic dislocation that has occurred in parts of the Arab world in recent years," said Paul Rawkins, a senior director at Fitch Ratings.

A marked increase in the unrest could also deter tourism. About 37.7 million visited Turkey in 2012, making it a top 10 destination globally. Tourist operators say there are not many cancellations so far, mainly because the protesters are not targeting visitors and the main sites — palaces, markets and beaches — are still accessible. But any sign that the clashes with protesters are becoming a more violent and widespread confrontation would likely have an impact.

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WHAT TO WATCH OUT FOR?

Besides a nasty turn in the protests, a particularly big risk factor for the Turkish economy, like other emerging economies, could come from beyond its shores — the U.S. Federal Reserve.

The Fed's policy of stimulating the economy with a bond-buying program has lowered returns for assets like U.S. Treasuries and encouraged investors to look for higher returns in other markets, like Turkey.

Moody's vice-president Sarah Carlson said the protests come "at an inopportune time" for Turkey if the Fed does reduce the amount of new money it is creating as part of its monetary policy.

The Turkish government would hope to have solved its political standoff by then.